Fed Can’t Save Economy So Politicians Better Get to Work: View

June 22 (Bloomberg) -- Ben Bernanke is running out of
bullets. That should be a sobering fact for politicians still
bent on playing games with the debt limit.

On national television today, the Federal Reserve chairman
painted a picture of a recovery that, two years after it began,
remains “frustratingly slow” and too weak to make a meaningful
dent in joblessness anytime soon. Even if the current slowdown
proves temporary, as the Fed expects, its forecast pace of
growth won’t bring unemployment back down below 7 percent until
after 2013.

Much more troubling is the country’s lack of a backup plan
if things get worse. The economy’s weakness leaves it vulnerable
to shocks of the kind that Europe’s festering sovereign-debt
crisis could easily deliver. But neither the Federal Reserve nor
the U.S. government is in a good position to provide more life
support should it become necessary.

Having already spent some $2.3 trillion on two bond-buying
programs aimed at lowering interest rates and boosting growth,
Bernanke recognizes that the costs of a third round of so-called
quantitative easing may outweigh the benefits.

For one, the recent acceleration in inflation presents a
genuine risk, and also provides ammunition for political scare-mongering that could negate any positive effect on confidence
and stock prices.

Record Cash Levels

What’s more, businesses and consumers don’t stand to gain
much from slightly lower interest rates. Companies are already
sitting on record levels of cash, and most homeowners who can
refinance their mortgages have already done so. Further easing
could give U.S. exporters an edge by pushing down the dollar’s
exchange rate against other currencies, but that can only go so
far before central bankers in other parts of the world
retaliate.

Indeed, even the most recent $600 billion round of
quantitative easing has had mixed results. It appears to have
helped fend off deflation, but its effect on growth has been
muted at best. The Fed currently expects the economy to grow at
an inflation-adjusted rate of between 2.7 percent and 2.9
percent this year, down from an estimate of 3.4 percent to 3.9
percent in January.

The country’s only other emergency backup would be
increased government spending. Already, economists at Goldman
Sachs Group Inc. estimate that as the federal stimulus tapers
off, the slowdown in spending will shave about half a percentage
point from annualized economic growth in the second half of this
year, and more next year.

Fiscal Stimulus

Done right, another $1 trillion or more in fiscal stimulus
wouldn’t necessarily worsen the government’s debt burden. If,
for example, massive, visible public-works spending managed to
create jobs and improve confidence, stronger growth could ease
the debt-to-GDP ratio automatically. This is unlikely to happen;
the political currents are flowing in the opposite direction.

Fortunately, other approaches could have a similar effect:
For maximum impact on jobs, the government might offer a tax
credit commensurate to the number of new workers that firms add
to their payrolls, as proposed by Alan Blinder, a Princeton
University professor of economics.

Here, too, officials’ hands are tied. Unless politicians
put the government’s long-term finances on a sustainable track
by agreeing on how to rein in or pay for obligations such as
Medicare and Medicaid, any extra spending now will look
irresponsible. As countries from Russia to Greece have learned,
markets may react by driving up the interest rate the government
must pay on its borrowings, making the debt much harder to bear.
As Bernanke put it today: “I do think in my role as somebody who
is extremely interested in financial stability, that addressing
the medium-to-long-term deficit problem is very urgent.”

Realism and Clarity

Realism and clarity are what taxpayers, businesses and
markets need from the political system. An agreement in
principle on what part of society -- retirees, workers,
employers, homeowners, consumers -- ultimately will pay to fix
the government’s finances, either through cuts in services or
higher taxes, would go a long way toward restoring confidence.
It should include mechanisms that guarantee the fix will happen,
yet allow some leeway if the economy worsens.

Instead, politicians are engaging in high-stakes haggling
over immediate budget cuts as they approach an August deadline
for raising the federal-debt limit. If they don’t reach a deal,
they risk triggering immediate, sharp spending cuts and a
downgrade of the U.S. government’s AAA credit rating. Such a
shock could quickly erase the meager gains the U.S. economy has
made in the course of the recovery.

Brinkmanship makes for good political theater, and can do
wonders for individual politicians’ careers. Unfortunately, as
Bernanke made clear on a sweltering day in Washington, it’s a
luxury the U.S. can’t afford right now.